How To Max Out Your TSP Contributions
This part of your TSP is the most important thing you can do and is a part of the process where you can have total control! Nothing is more important than what you put into your TSP. There is an old saying that goes, "It takes money to make money." This is a true statement.
There are several ways to fund your TSP. The main goals are to max out the TSP to whatever the limits allow at a particular time. Currently it is $18,500 per year if you are under age 50. Once you reach the year you turn 50, you can put in an extra $6,000, for a total of $24,500. Getting to these amounts is the cornerstone of reaching your target goals. I previously said you want to get to at least $500,000 before your retire but the reality is you can get to $1,000,000 or more. You do not have to be a financial genius or be a stock broker. You just have to have the will to focus on this process and ensure you are putting in enough funds to make this a reality. Also, there is one other point that you will have to consider as you do this process: You will have to sacrifice.
But lets start with the most basic issues before we talk about sacrifice. $500,000 gets you about $2,500 per month after retirement for 30-40 years. $1,000,000 gets you to $5,000 per month. That is with modest returns of 4% - 5% - 6%. There is no reason you can not get to these numbers unless you allow it to happen to you. I know what you are thinking: How can put I put $18,500 to $24,500 into the TSP. I have bills to pay. I want to go on vacations with my family. I want to buy a house. My kids are applying to college....
You may have some of these things along with a healthy TSP. You may not be able to have all of them. But the main issues of TSP are based on some basic truths:
1. The more funds you put into your TSP lowers your taxable income. You need to lower your taxable income. If you do not, the IRS will take your money. So you have a choice: You can give it to the IRS or you can put it into the TSP to make your retirement more comfortable. As you make more money in your government career, you will move into higher tax brackets and more money will be taxed and going to the IRS.
The current new tax program is only going to last 5 years and then it goes back to the previous tax schedules. Once you reach certain income limits, some of you may encounter the Alternative Minimum Tax (AMT), which starts to take away some basic deductions you have been used to taking, like the property tax deductions and the state tax deductions. It will be a shock when you encounter the AMT. The reality is that once you get to 20-30 years in your career, you may be getting taxed into 30% - 40% tax brackets, especially if you have a spouse that works and you are getting hit by the AMT. As middle class government employees, you do not have many options to lower your taxable income. Putting money into the TSP is one of the main alternatives.
2. Once you set up your TSP funding strategy, it does not have to be painful or worrisome. Yes, you may want to use some of that money for other things, but once you start your TSP strategy it gets easier every year.
3. In order for any of the following strategies to work, you have to be either in the L Funds, or the C, S and I funds. You cannot succeed if you stay in the G Fund. I talked about this in my last month's blog. You have to have some reasonable growth in order for your TSP to grow, no matter how much money you put into it. By reasonable, I mean the 5% - 6% - 7% range but you don't have to take extreme risk either.
So here are some strategies that can work for you. They are not complex or time consuming or too difficult to work with. These are basic ideas that will work.
Option #1: When you start your government career, you want to fund your TSP with at least 5% of your salary to match the government's 5%. This is no brainer folks. You have to start with this.
Then you can decide how to increase your contributions. The most painless way is to increase your contributions each year a little at a time until you get to the max of $18,500. So if you start with the 5% and increase your funds by $1,000 per year, that amounts to an increase of $39 per pay period per year. I think every federal employee can increase their TSP by $39 per year per pay period. That gets you to $18,500 in about 15 years and sets you up to get closer to the $24,500 goal we talked about at 50 years of age. We don't want to try to go from 5% of your pay to $18,500 too fast. I think that would be too big an increase for most people. But this is an approach that lets you creep up your contributions and not financially hurt you at the same time. This will get you to seven figures in about 25 - 30 years. If you want to be a little more ambitious you can also increase by $2,000 a year, then it would increase by $78 per pay period per year.
Option #2: If you want to start at a higher percentage of your salary, this will help you increase your payments each year at a lower amount but still gets you to seven figures in about 22 - 26 years.
You can start with 10% or 15% of your salary in the first year. Then increase your TSP contributions each year by $360 for the 10% option and about $540 for the 15% option. That equals $21 an increase per pay period per year for 15% and $14 an increase per pay period per year of the 10% option. I would seriously consider the 15% option between these two amounts. I know you can do it.
Another easy way to calculate these numbers is to just multiply the government matching dollar amounts by 2 if you want to use 10% and by 3 if you want to equal 15%.
So as you can see, you can start lower with 5% and increase $1,000 per year, or start higher with 15%, then increase about $300 - $500 per year. Either option will get you to max out the TSP. Once you get to the year 50, then you can make the final increase of $6,000 to max out at $24,500. That will be the final adjustment you will have to make once you get to that age group.
But now you say, "$6,000???? That's a big chunk of money. I need that money." Yes, I understand you need that money but we go back to what I said above. By the time you reach the year you turn 50, you will be probably be getting into higher tax brackets due to your higher salary. If you don't put it away into the TSP, a lot of it will be gone to taxes. It will. Let me put it another way: You don't really have $6,000 to pay your bills. You will only have $3,000 - $4000. That other $2,000 is gone. That's a lot of money to give away. It becomes such a big deal to add that to your TSP. That can be the difference of having $500,000 or getting to $1,000,000 plus.
One major consideration about your TSP growth: By the time you reach the year you turn 50, if you do max out your TSP with the $24,500, your TSP will DOUBLE from the age of 50 to 56 - 57. Yes, DOUBLE! That means you will make as much between 50 to 57 as you made from the 25-30 age group to 50 years of age because your TSP amounts are getting bigger and bigger. That is a tremendous incentive to max out your TSP.
One other consideration. When you do these calculations, make sure you use actual dollar amounts for your TSP contribution forms. If you use percentages to make your TSP contributions, it will be harder to keep track of your yearly increases and pay period adjustments. Make the calculations with the percentages but use actual dollar amounts on your TSP forms. It's much easier.
Option #3: One other option that can be used is by increasing your TSP fund contributions by your annual pay increases or regular GS level or step promotions that are part of your regular federal career advancements. This will work as well but it might be a little hard for you to plan until you know when those pay increases or promotions actually take place. It's another way to increase your contributions but may not give you the luxury of planning your TSP increases the way you can with the other two options.
During my career, the TSP funding was not as fully formed as it is now. Since the early 1990s to present, the amount to put into your TSP changed over time, slowly. It started pretty low and gradually built up to $18,500 and $24,500. But it still worked and I was able to get to my target goals. It's just easier to budget and see your TSP growth when you know what you are going to add to your TSP on a year to year basis.
Now lets talk about sacrifice. Let me tell you one final story, to put this process into perspective. I know you want to keep your money to pay bills instead of putting it into TSP now. I know it is painful to have to make these hard decisions. Let me tell you what I did. Just for clarity:
During my career, my wife and I made a decision to put our two children in private school. That was both our decisions and we stand by those decisions, but it was very painful. Those schools were absolutely expensive. We could not pay our bills the way we wanted to and do other things we wanted to do without that money we put into TSP and my wife's 401k similar to a TSP. So for about 20 years it was brutal but we are glad we did the private school option and now my kids are in college and doing well. We are now doing better financially and paying off our bills.
But no matter how bad it became and no matter what financial issues affected us, we always, always maxed out our TSP and 401k, every year until I retired. I would always max out those funds first, then pay my bills with the rest of the money left over and because of that I am now very financially comfortable in my retirement and my wife is right behind me. I kept my vision on the end game and by both of us maxing out our TSP contributions each by $24,000, we were able to reduce our taxable income by $48,000 each year. That was a tremendous help against the AMT.
I only tell you this story so that you can think about what you are doing with your money. You will have to make some major decisions about your TSP. I can't tell you what to do. You have to decide what is best for you and your family. Just think about the end game here. We are all going to get there sooner or later.
Next month I will talk about different strategies to make withdrawals out of your TSP when you retire. These won't be complex either. Just simple ideas that work and will keep your TSP income stream paying you for the next 30 - 40 years. Good Luck!